Forget ENSCO PLC: Seadrill Partners LLC Is a Better Dividend Stock

The offshore-drilling sector used to be a great source of dividend income. However, those payouts all came down along with oil prices , and now just two companies still pay dividends: Seadrill Partners (NYSE: SDLP) and ENSCO ‘s (NYSE: ESV) . For income investors, there’s just one option between these two, since Seadrill Partners yields a generous 10.3%, while ENSCO’s payout is a meager 0.6%.

While the double-digit yield certainty causes some doubts about its long-term sustainability, especially given the continued struggles of the offshore-drilling sector, Seadrill Partners has the resources to keep paying it for a very long time. Investors, though, need to carefully consider the risk that still comes with this high yield, which might not be worth the reward since there are even better high-yield options available elsewhere in the energy sector.

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Drilling down into Seadrill Partners’ dividend

While Seadrill Partners currently has a sky-high yield, it can easily cover the payout with cash flow. In fact, through the third quarter of last year, Seadrill Partners made $47.1 million in cash distributions to investors, which represented just 12% of the company’s cash flow from operations over that time frame. For perspective, ENSCO paid out only $9.4 million to its investors over that time frame, which was about 4% of its operating cash flow.

While both companies can easily cover their current payouts, the coverage has tightened in the past year. Seadrill Partners’ cash flow, for example, is down about 50% while ENSCO’s plunged by more than three-quarters. Meanwhile, Seadrill Partners’ cash flow will likely continue falling since it has six offshore drilling vessels going off contract this year. That said, the offshore driller does have $1.7 billion of revenue in its contract backlog, which means cash flow won’t completely dry up, either.

In addition to that near-term revenue visibility, Seadrill Partners also had $845.3 million in cash at the end of last quarter, which was higher than ENSCO’s $724.4 million cash pile. For perspective, that’s enough money so that both companies could maintain their current dividend rate for more than a decade. But the big concern is that both offshore drillers do have more than $3 billion in debt apiece, which could come between them and their dividend if industry conditions don’t improve.

Image source: Getty Images.

Better days ahead?

The question investors want to have answered is when those operating conditions will get better. While the timing is anyone’s guess, analysts at UBS said last fall that they thought offshore rig utilization would improve slightly this year, followed by greater demand growth in 2019 and 2020, assuming crude was in the high-$50s to low-$60s. But with oil recently rebounding into the upper $60s, it could help move things along more quickly, since oil companies will have more cash flow. That could give them incentive to sanction new projects, which could put more offshore drilling rigs back to work than currently expected. That scenario could enable Seadrill Partners to secure new contracts for both its idle rigs and those with expiring contracts, which could help put a bottom under its cash flow and provide more support for the dividend.

This high yield still isn’t for the faint of heart

Seadrill Partners is by far the best dividend stock in the offshore-drilling sector, though that’s not saying much, since it’s just one of two companies that still pay a dividend. Still, given that it appears the company can maintain that payout while it waits for industry conditions to improve, it is an option for those starving for yield. Of course, investors need to be aware that this high yield comes with a high level of risk, since it still has a boatload of debt. For that reason, investors might want to consider one of the better opportunities found in other parts of the energy sector.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool owns shares of Ensco. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.